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Earnings, value and EMs: the market trends for 2021 in charts



It has been a head spinning year for investors. The global Covid-19 pandemic triggered a stunning rout in equity markets. Then came a sharp recovery driven by the rapid response from governments and central banks. Here’s a look at that year in charts and what they suggest for 2021:

The key to this year’s rebound in equities and corporate bonds from the lows was the sheer scale of central bank support.

A gush of government bond purchases has anchored long term interest rates at extremely low levels and will continue during 2021, albeit at a reduced pace. JPMorgan’s strategy team expects $5tn of global central bank balance sheet expansion in 2021. “Central bank balance sheet expansion in 2021 might be only half of 2020, but that pace would still be associated with asset price inflation,” it says.

Column chart of Assets ($tn) showing The large central banks added $8tn to their balance sheets this year

Tech and high quality stocks led the way from the depths of March, but during the second half of the year, investors started rotating towards stocks more sensitive to the economic cycle, cheaper “value” stocks and high-yield bonds. That has been spurred by expectations of a broader economic rebound next year as vaccines for Covid-19 are rolled out. Regulatory approvals of vaccines have accelerated the pace of a broad market rotation, with smaller companies seeing strong gains.

Bar chart of Equities and credit surge from their March lows showing Market performance dictated by central bank action this year

The bounce from March is certainly impressive but does raise a concern that markets have borrowed heavily from 2021 returns. Global and US share markets are set to record two consecutive years of double digit gains and history suggests that a string of three straight years of double digit gains is rare but can occur.

Column chart of Total return over calendar year (%) showing The US has led global equities into another year of double-digit growth

So does 2021 extend the streak? Or will already high valuations weigh on returns?

The answer rests with the scale of an anticipated corporate earnings recovery next year. As shown here, the current consensus estimate for bottom-up earnings per share for the S&P 500 for the 2021 calendar year is $169.20, which would represent an increase of 21.7 per cent from 2020. That would represent a record high EPS for the blue-chip benchmark and would come after a forecast earnings decline of 13.8 per cent in 2020.

Bar chart of S&P 500 earnings per share estimates versus results showing Wall Street is usually too bullish on earnings

One wrinkle is that estimates by Wall Street for earnings over the next year are usually 7 per cent too high according to John Butters, senior analyst at FactSet. Apply that factor and 2021 EPS would deliver an actual figure of $157.32, falling short of the 2018 and 2019 actual EPS numbers of $161.45 and $163.02 respectively.

However, there is a case for arguing earnings might be one area that positively surprises. The pandemic sparked a dramatic effort by companies to hoard cash via costing cutting and the slashing of buybacks and dividends.

“Companies did not view this as a normal recession and cut their costs to the bone in order to survive,” said James Paulsen, chief investment strategist of The Leuthold Group. “Minimal costs on an operational basis means rising demand powers up profits.”

An earnings rebound next year is critical because valuations sit well above their average levels. Higher earnings will reduce extended valuation multiples over time. But as shown in this chart below of trailing 12 month price to earnings per share by Northern Trust Asset Management, all the main regional markets sit above their long term average.

Column chart showing equity price/earnings ratios - normal ranges and current

Wall Street certainly stands out for being more expensive than rivals. This might favour emerging market equities in 2021 and more cyclical companies. The argument is that they will experience a bigger bounce in earnings growth from a stronger economic recovery and a weaker US dollar.

The dollar’s performance is important because it helps boost global growth and corporate earnings. The chart below highlights how Wall Street can lag the rest of the world arise when the reserve currency enters a sustained bear trend. Rising local currencies help boost returns for global investors holding non-US equities.

Line chart of Indices, 31 Dec 1971 = 100 showing A weaker dollar tends to boost non-US stocks

A broader and more global equity rally suggests better times for advocates of buying value stocks, cheap companies that over the past decade have badly lagged the performance of faster growing rivals. As seen here, the ratio of value versus growth companies has recently turned upwards, but it paints a sorry picture since 2007.

Line chart of global value stocks relative to growth stocks (using MSCI All World indices, end-1999 = 100) showing cheaper 'value' stocks have underperformed for over a decade

Expectations of a robust recovery that accelerates during 2021 hinge on a return to normal after mass Covid-19 vaccinations. But “normal” in a financial market context means higher long-dated interest rates.

The Bloomberg Barclays global bond index includes government and corporate bonds that are investment grade quality. Falling yields have been a pervasive and entrenched trend. The global index with an average maturity of 9 years, currently sits at 0.84 per cent, down from 2.79 per cent over the past decade.

Line chart of Yield on Bloomberg Barclays Global Aggregate Bond index* (%) showing Falling bond yields have been an established trend

The persistent decline in bond yields against the backdrop of low inflation and the bulging presence of central bank balance sheets over the past decade leave investors in a degree of suspense from here. No one can be certain that a decade of secular stagnation will cede to a cycle of faster, more inflationary growth that is more inflationary, thereby rewarding equity holders and threatening returns for bond investors.

“While equity investors are welcoming the 2021 growth cycle, bond investors continue to focus on the longer term where growth will probably resume at a slow trajectory and inflation will remain a problem for another day,” says Katie Nixon, chief investment officer at Northern Trust Wealth Management.

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Financial bubbles also lead to golden ages of productive growth




Sir Alastair Morton had a volcanic temper. I know this because a story I wrote in the early 1990s questioning whether Eurotunnel’s shares were worth anything triggered an eruption from the company’s then boss. Calls were made, voices raised, resignations demanded. 

Thankfully, I kept my job. Eurotunnel’s equity was also soon crushed under a mountain of debt. Nevertheless, the company was refinanced and the project completed. I raised a glass to Morton’s ferocious determination on a Eurostar train to Paris a decade later.

With hindsight, Eurotunnel was a classic example of a productive bubble in miniature. Amid great euphoria about the wonders of sub-Channel travel, capital was sucked into financing a great enterprise of unknown worth.

Sadly, Eurotunnel’s earliest backers were not among its financial beneficiaries. But the infrastructure was built and, pandemics aside, it provides a wonderful service and makes a return. It was a lesson on how markets habitually guess the right direction of travel, even if they misjudge the speed and scale of value creation.

That is worth thinking about as we worry whether our overinflated markets are about to burst. Will something productive emerge from this bubble? Or will it just be a question of apportioning losses? “All productive bubbles generate a lot of waste. The question is what they leave behind,” says Bill Janeway, the veteran investor.

Fuelled by cheap money and fevered imaginations, funds have been pouring into exotic investments typical of a late-stage bull market. Many commentators have drawn comparisons between the tech bubble of 2000 and the environmental, social and governance frenzy of today. Some $347bn flowed into ESG investment funds last year and a record $490bn of ESG bonds were issued. 

Last month, Nicolai Tangen, the head of Norway’s $1.3tn sovereign wealth fund, said that investors had been right to back tech companies in the late 1990s — even if valuations went too high — just as they were right to back ESG stocks today. “What is happening in the green shift is extremely important and real,” Tangen said. “But to what extent stock prices reflect it correctly is another question.”

If the past is any guide to the future, we can hope that this proves to be a productive bubble, whatever short-term financial carnage may ensue.

In her book Technological Revolutions and Financial Capital, the economist Carlota Perez argues that financial excesses and productivity explosions are “interrelated and interdependent”. In fact, past market bubbles were often the mechanisms by which unproven technologies were funded and diffused — even if “brilliant successes and innovations” shared the stage with “great manias and outrageous swindles”.

In Perez’s reckoning, this cycle has occurred five times in the past 250 years: during the Industrial Revolution beginning in the 1770s, the steam and railway revolution in the 1820s, the electricity revolution in the 1870s, the oil, car and mass production revolution in the 1900s and the information technology revolution in the 1970s. 

Each of these revolutions was accompanied by bursts of wild financial speculation and followed by a golden age of productivity increases: the Victorian boom in Britain, the Roaring Twenties in the US, les trente glorieuses in postwar France, for example.

When I spoke with Perez, she guessed we were about halfway through our latest technological revolution, moving from a phase of narrow installation of new technologies such as artificial intelligence, electric vehicles, 3D printing and vertical farms to one of mass deployment.

Whether we will subsequently enter a golden age of productivity, however, will depend on creating new institutions to manage this technological transformation and green transition, and pursuing the right economic policies.

To achieve “smart, green, fair and global” economic growth, Perez argues the top priority should be to transform our taxation system, cutting the burden on labour and long-term investment returns, and further shifting it on to materials, transport and dirty energy.

“We need economic growth but we need to change the nature of economic growth,” she says. “We have to radically change relative cost structures to make it more expensive to do the wrong thing and cheaper to do the right thing.”

Albeit with excessive enthusiasm, financial markets have bet on a greener future and begun funding the technologies needed to bring it to life. But, just as in previous technological revolutions, politicians must now play their part in shaping a productive result.

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US tech stocks fall as government bond sell-off resumes




A sell-off in US government bonds intensified on Wednesday, sending technology stocks sharply lower for a second straight day.

The yield on the 10-year US Treasury bond, which acts as a benchmark for global borrowing costs, climbed to nearly 1.5 per cent at one point. It later settled around 1.47 per cent, up nearly 0.08 percentage points on the day.

Treasury trading has been particularly volatile for a week now — 10-year yields briefly eclipsed 1.6 per cent last Thursday — but the rise in yields has been picking up pace since the start of the year and the moves have begun weighing heavily on US stocks.

This has been especially true for high-growth technology companies whose valuations have been underpinned by low rates. The tech-focused Nasdaq Composite index was down 2.7 per cent on Wednesday, on top of a 1.7 per cent drop the day before.

The broader S&P 500 fell by 1.3 per cent.

The US Senate has begun considering President Joe Biden’s $1.9tn stimulus package, with analysts predicting that the enormous amount of fiscal spending will boost not only economic growth but also consumer prices. The five-year break-even rate — a measure of investors’ medium-term inflation expectations — hit 2.5 per cent on Wednesday for the first time since 2008.

Inflation makes bonds less attractive by eroding the value of their income payments.

“I would expect US Treasuries to continue selling off,” said Didier Borowski, head of global views at fund manager Amundi. “There is clearly a big stimulus package coming and I expect a further US infrastructure plan to pass Congress by the end of the year.”

Mark Holman, chief executive of TwentyFour Asset Management, said he could see 10-year yields eventually trading around 1.75 per cent as the economic recovery gains traction later this year.

“It will be a very strong second half,” he said.

Line chart of Five-year break-even rate (%) showing US medium-term inflation expectations hit 13-year high

Elsewhere, the yield on 10-year UK gilts rose more than 0.09 percentage points to 0.78 per cent, propelled by expectations of a rise in government borrowing and spending following the UK Budget.

Sovereign bonds also sold off across the eurozone, with the yield on Germany’s equivalent benchmark note rising more than 0.06 percentage points to minus 0.29 per cent. This was an example of “contagion” that was not justified “by the economic fundamentals of the eurozone”, Borowski said, where the rollout of coronavirus vaccines in the eurozone has been slower than in the US and UK.

The tumult in global government bond markets partly reflects bets by some traders that the US Federal Reserve will be pushed into tightening monetary policy sooner than expected, influencing the costs of doing business for companies worldwide, although the world’s most powerful central bank has been vocal that it has no immediate plans to do so.

Lael Brainard, a Fed governor, said on Tuesday evening that the ructions in US government bond markets had “caught my eye”. In comments reported by Bloomberg she said it would take “some time” for the central bank to wind down the $120bn-plus of monthly asset purchases it has carried out since last March.

After a series of record highs for global equities as recently as last month, stocks were “priced for perfection” and “very sensitive” to interest rate expectations that determine how investors value companies’ future cash flows, said Tancredi Cordero, chief executive of investment strategy boutique Kuros Associates.

Europe’s Stoxx 600 equity index closed down 0.1 per cent, after early gains evaporated. The UK’s FTSE 100 rose 0.9 per cent, boosted by economic support measures in the Budget speech.

The mid-cap FTSE 250 index, which is more skewed towards the UK economy than the internationally focused FTSE 100, ended the session 1.2 per cent higher.

Brent crude oil prices gained 2 per cent at $64.04 a barrel.

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UK listings/Spacs: the crown duals




City-boosting proposals are not enough to offset lack of EU financial services trade deal

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